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How Far Can the Euro Rise?

Kathy Lien, Director of Currency Research, GFT





  11/02 Meeting 12/13 Meeting
NO CHANGE 68.3% 64.5%
CUT TO 0BP 31.7% 33.7%
HIKE TO 50BP 0.0% 1.8%
CUT TO 75BP 0.0% 0.0%



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The euro fell sharply against the U.S. dollar today, extending a move that has taken the currency pair from a high above 1.45 down to a low of 1.3240 in just over a month.  With today’s sell-off, the EUR/USD has erased all of its year to date gains and the biggest question on everyone’s minds is how much further can the EUR/USD slide. On Friday, we wrote that further weakness is likely and considering the lack of progress on increasing measures to prevent contagion and continued delays on releasing the next bailout payment to Greece, the euro is vulnerable to even further losses. More specifically, we do not expect EU Finance Ministers to a make a decision to release funds to Greece at their meeting this week nor do we expect them to be able to reach an agreement on expanding the European Financial Stability Facility (EFSF). In fact, the main reason why the euro extended its slide today is because public disagreements on the EFSF has discouraged investors who had been hoping for progress on a larger bailout plan for the region. This morning, Luxembourg Finance Minister Frieden downplayed the need for increasing the EFSF while Spain’s Salgado said the fund should have more capacity but does not need amplification. Finland also does not want to raise the EFSF capacity but are open to discussing leveraging the fund. At the end of the day, comments from European Finance Ministers suggests that they are not getting any closer to enlarging the EFSF enough to handle further contagion and for this reason, we would not be surprised if the EUR/USD made a run for 1.30. Credit default swap spreads have increased across Europe as fears of a Greek default continue to weigh on the markets. Even ECB member Mario Draghi, who will be Trichet’s successor, expressed his concerns that there could be major funding problems in the banking sector.  Based upon the price action in the euro, investors are starting to look to the European Central Bank for support. The ECB has a monetary policy announcement this week and there is a small chance that they will reduce interest rates and Draghi’s concerns about the banking sector suggests that he may not be entirely opposed to it. Speculation about easier monetary policy for Europe could be another reason why the euro could remain weak for the rest of the week. Eurozone producer prices are scheduled for release on Tuesday along with revisions to Eurozone service sector PMI reports. Given the decline in German and French producer prices, we expect inflationary pressures in the Eurozone to decline. Meanwhile the Swiss appear to be happy with the Franc at 1.20 against the euro according to the SNB Finance Minister who said the cap is currently at the right level. The latest reports show Swiss retail sales and manufacturing activity slowing which is not much of a surprise considering the negative impact that a strong Swissie has had on the overall economy.


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Based upon the weakness in currencies and equities this morning, this quarter could be as challenging as the last. We are moving into the last few months of the year and the first official day of trading in the fourth quarter has started off on very soft footing. Traditionally October is also a very negative month for stocks and risk. With the abundance of event risks this month and the number of uncertainties and unanswered questions, further weakness is definitely a possibility. Despite reports of stronger manufacturing activity in September, investors continue to reduce risk and seek safety in low yielding currencies. The U.S. has its own troubles but Treasuries are continuing to benefit from a flight to quality. Investors are worried that they will be disappointed by policymakers and economic data and their concerns are justified given recent commentary from central bank officials. We believe that currencies will trade heavy for most of the week as central banks join the Fed's call for easier monetary policies. Despite signs of higher inflationary pressures in some parts of the world, slower global growth and heightened uncertainty is undeniable. The U.S. dollar could be a big beneficiary if we hear any dovish comments from the four central banks meeting this week.   The only economic reports released this morning were manufacturing numbers from the U.S., Europe and Switzerland. According to the Institute of Supply Managers, manufacturing activity in the U.S. accelerated in the month of September. Unlike other parts of the world, the manufacturing sector has enjoyed growth every month for the past year but as encouraging as this may be, the U.S. is a service and not manufacturing driven economy which explains why the impact of the stronger report on the dollar and risk appetite was limited. The ISM index rose to 51.6 from 50.6 thanks to higher prices, increased production, supplier deliveries, customer inventories, new export orders and employment. Construction spending also rose 1.4 percent in August, erasing the past month's decline. Despite these improvements, central bank officials are still open to the idea of more stimulus but may not be ready to pull the trigger just right now.  According to Fed President Fisher, the central bank has “plenty of ammunition” if the economy is horrific” but there is “some minor momentum in the economy.”  Factory orders is the only piece of U.S. data on the calendar tomorrow but comments from Fed Chairman Ben Bernanke could trigger some volatility. Bernanke is scheduled to testify before the Joint Economic Committee on the Economic Outlook and investors will be listening in closely to see just how close the Fed is to increasing stimulus once again. He will most likely be presented with questions about the market’s reaction to Operation Twist and if he shows even a modicum of dissatisfaction, speculation about QE3 could gain traction. 


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The British pound also weakened against the U.S. dollar despite stronger economic data. After contracting for two straight months, manufacturing activity expanded in the month of September. The details of the report show an increase in new orders, new export orders and prices. The employment subcomponent also rose slightly but remained in contractionary territory, reflecting a decline in employment. With PMI numbers due from the manufacturing, service and construction sector this week, we will get a much better sense of how the U.K. economy is faring. The Bank of England will be holding a monetary policy meeting on Thursday and based upon the minutes from recent central bank meetings, the MPC is getting closer to increasing stimulus. However the increase in manufacturing activity and the slight rebound in consumer confidence could delay their decision. Once the BoE pulls the trigger on another round of asset purchases, it will be very difficult for them to reverse the move and the market’s expectations. As a result, the decision will not be made lightly and so the central bank could opt to delay the decision until the very last moment when markets become even more volatile. According to Hometrack, house prices fell another 0.1 percent in the month of September, which shows weakness in other parts of the economy. On Tuesday, we expect the release of Construction sector PMI and it is expected to decline, reflecting a slower recovery. Bank of England policymaker Miles will also be speaking in Oxford and we will be listening in to his comments for any insight into the central bank’s decision on Thursday. 


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The Australian and Canadian dollars fell to a fresh one year low against the greenback while the New Zealand dollar fell to its lowest level in 6 months. The Reserve Bank of Australia will be making a monetary policy announcement this evening and the wide divergence between what investors and economists expect points to a potentially volatile reaction in the Australian dollar. Economists expect the central bank to leave interest rates unchanged at 4.75 percent but for the past few months, investors have been pricing in a 75 to 100bp rate cut by the RBA before the end of the year. For this meeting in particular, no one believes the RBA will lower interest rates but if the central bank were to cut in November like investors expect, they would need to move from a “wait and see mode” into a “we are gearing up to cut rates mode.” The problem is that even though the market has been discounting a series of rate cuts by the RBA before year’s end, the central bank has refused to acknowledge the need for stimulus. If they continue to ignore the calls for easing, A$ traders may have no choice but to cut their short positions. When the RBA last met in September, monetary policy officials felt that they were well equipped to handle slower global and domestic growth or an increase in inflation. They emphasized the continuation in the mining investment boom and high terms of trade. More recently, RBA officials downplayed the significance of the U.S. economy on domestic growth and spoke of the increasing importance of China, which is clearly their attempt to tell investors that for the time being, demand from China continues to shelter them from the global economic troubles. With little consistency in economic data, the only major changes since September for the RBA to consider are the increased volatility in the financial markets, the recent downgrades across the globe and the sharp slide in the Australian dollar. In early September, the AUD/USD was trading around 1.05/1.06 and on the eve of the RBA meeting, the currency pair is 8 to 9 percent weaker. In some ways, it can be argued that the weaker currency gives the RBA more flexibility to lower rates, but at the same time, it is also more stimulative for Australia’s economy, reducing the need for a rate cut.   This lack of clarity is the main reason why we believe the RBA will remain firmly neutral, which could trigger a relief rally in the AUD/USD. 


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The Japanese Yen traded higher against all of the major currencies, rising to a fresh 10 year high against the euro, 2 year high against the Canadian dollar and 1 year high against the Aussie. The rally in the Yen is purely a function of risk aversion because the Tankan survey of business sentiment was mixed. Even though the rise in the Tankan large manufacturers index from -9 to 3 shows that business sentiment improved, the reading was below pre-earthquake levels. Japanese businesses are resuming activity after the quake but the global economic slowdown and the strong yen has them concerned about demand going forward. The Japanese government is monitoring economic data very closely to see how much of an impact the currency is having on the economy but at the end of the day, they have yet to follow words with new action. Perhaps they have just grown accustomed to a strong Yen and won’t come into the market unless USD/JPY falls below 76 or they are working behind the scenes with their international counterparts to put together some type of global response that would boost risk appetite across the markets. We are hopeful that the latter is the case and the November G20 Leaders meeting would be a perfect venue for this type of announcement. 

AUD/USD: Currency in Play for Next 24 Hours

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The AUD/USD will be our currency pair in play for Tuesday. Australia will be releasing building approvals and its trade balance report at 20:30 NY Time / 0:30 GMT followed by the RBA announcement at 23:30 NY Time / 3:30 GMT. The U.S. has factory orders scheduled for release at 10:00 AM ET or 14:00 GMT. 

The AUD/USD has fallen sharply this month and is currently trading comfortably in a downtrend, which we determine using Bollinger Bands. To find support in the currency pair, we have to turn to weekly charts. 95 cents is a psychologically significant support level but more significant support should be at 94 cents which is a former breakout point for the AUD/USD. Should the currency pair trickle higher, the 10-day SMA and first standard deviation Bollinger Band should serve as support at 98 cents.